[This review was published in the Summer 2009 issue of The
Journal of Social, Political and Economic Studies, pp. 260-267.]

Book Review

The World is Curved:
Hidden Dangers to the Global Economy

David M. Smick

Portfolio, 2008

Imagine you
walk into a saloon in Texas and
are told it has just acquired a “Super-Colossal Electric Bull” for the
customers to ride.You are told that the
ride is more exhilarating than electric bull riders have so far ever
experienced.But there is a caution: on
average, one in every three riders is sent flying through the ceiling.Ambulances stand by outside to take them to
the hospital or the morgue.

You might
feel that anyone with sense will refuse to ride.But the saloon has hired an expert in
electric bull riding who insists that “you haven’t lived unless you’ve ridden
the bull.The risk is just something
you’ll have to accept.”

Most
likely, you will consider the expert a modern-day Mephistopheles, a devil
seeking to seduce you to your doom.Unlike Faust, you will reject the seduction.

Opening the
pages of The World is Curved is like
walking into the saloon.The expert in this
case is David M. Smick, one of global finance’s top monetary advisors.He has for twenty years edited The International Economy, a magazine he
founded that is “geared to the global central bank and finance ministry
community.”Smick runs a “global macroeconomic
advisory firm” and tells of giving advice to U.S.
presidential administrations of both parties.Just as Thomas Friedman’s striking description of global business in The World is Flat reflects first-person
contact with national and corporate leaders around the world, Smick’s
experience includes meetings over several years with top global finance
ministers.

It isn’t an
electric riding bull that Smick praises as so exhilarating; it is the great
swirling pool of global finance, which brings the world the benefits of
entrepreneurial dynamism.“We will not
have lived,” he in effect says, if we don’t continue to reap the spectacular
rewards of that dynamism.But along with
his enthusiastic endorsement comes a spine-tingling warning: that at any given
moment the unforeseeable vicissitudes of global finance threaten to launch the
world over a precipice into a catastrophic international economic
collapse.In effect, ambulances stand by
to take us all to the hospital or morgue.

He has much
to tell about global finance.As
economic globalization has become magnified during the past quarter-century, a
“raging ocean of capital” amounting to “hundreds of trillions of dollars” has
served as the monetary lubricant, and “appears to know no limits.”Much of it is based on “leverage” (“borrowing
for investment”), which gives rise to “the leveraged global financial
risk-taker.”

Smick
describes how “financial markets have been internationalized through an
intricate web of financial engineering called securitization.”The financial tools found within this
“modernized, multilayered financial system” include, among others, “private
equity funds, private debt placements, hedge funds, high-yield bonds, venture
capital funds, turnaround funds, and private mezzanine investing.”At the time Smick was writing, there were
already 9,000 hedge funds, with their operators earning “enormous fees.”(Because Smick rightly assumes that not all
of his readers are fully conversant with these financial vehicles, he explains
“securitization,” “hedge funds,” “private equity investors,” and the like,
adding an additional dimension to an already very informative book.)

Computers
make instantaneous transfers of money and securities possible in a “world
loaded with cash.”A striking example
comes when he tells of the Japanese housewives.Since in Japan
husbands devote most of their waking hours to work, it is left to their wives
to handle the family finances.Japan
is the world’s largest repository of savings, and this means the housewives are
in control of a vast pool of cash to invest.Computer literate, they increasingly use the Internet to invest
directly, often across national boundaries.This introduces a highly unpredictable element, since tens of billions
of dollars can swing from one place to another at “the click of a mouse”
(actually quite a large number of mice), depending upon the extent to which the
housewives are susceptible to mass psychology.“Shifts of savings across borders [are] making the old financial models
obsolete.”

As with our
fanciful expert in electric bull riding, Smick praises the new mechanism as
something the world can ill-afford to do without.The benefits of “this phenomenal success” are
inestimable: “this quarter-century represents the most successful period of
mass poverty reduction in the history of mankind.”“Securitization” is “the system that
allocates capital so successfully for the industrial world.”This facilitates “the high-risk-taking
entrepreneurs [who] are the magic ingredient.”A United States
that has declined in most other economic efforts deserves much of (what Smick
considers to be) the credit, since he says “financial services remains one of
the industries in which the United States
globally is competitively superior.”Global finance has become so central to the U.S.
economy, indeed, that there is no way to “opt out of the system… without
experiencing brutally negative consequences.”If the world in general reacts to the “Great Credit Crisis of 2007-2008”
by rejecting globalization policies, it “will be risking nothing less than the
financial health of the global economy.”So we are told that not only is riding the bull wonderfully desirable;
not riding it is out of the question.

But, of
course, the analogy to the bull-riding in Texas
doesn’t stop here.The expert has yet to
tell us how extremely dangerous the riding is (in itself, and not just for
those who try to opt out).What Smick
has to say about the dangers provides the context for the book’s subtitle:
“Hidden dangers to the global economy.”It is no overstatement to say that the risks he describes are so many
and so palpable that any objective observer, such as the visitor to the saloon,
would be justified in considering them intolerable.It is amazing that, in light of what he tells
us, Smick holds fast to his professionally-engrained bias in favor of more of
the same.Here are some of his
admonitions:

It is well to start with his general
observations, which include: “…increased number of unknowns”... unbelievably fragile.It is a house of cards”… “The global system
is becoming more vulnerable with each passing month.” This explains why Smick
titles his book The World is Curved [as
distinct from being flat, as Friedman described it].Being curved, “we can’t see over the
horizon.”Such warnings have been made
for several years; in his 1997 book One
World, Ready or Not: The Manic Logic of Global Capitalism, William Greider
said that “our wondrous machine, withal its great power and creativity, appears
to be running out of control toward some sort of abyss.”

“The industrialized world has surrendered
control of its financial system to a tiny group of five thousand or so
technical market specialists spread through investment banks, hedge funds, and
other financial institutions.”

“What do
we know about the accuracy of the accounting ledgers of even our largest, most
trusted financial institutions or of the sophisticated financial instruments
these firms deploy?”

“The bankers who engage in lending are no longer
tied to the risk of the borrower… The lender no longer has incentive to avoid
dangerous risk… [The loans are] sold as investment to the unknowing global
financial community.” “The size of the financial markets, relative to
governments, has become so monstrously huge… [that] the governments themselves
cannot by edict restore order… The global economy is becoming increasingly
beyond the positive control of governments.”Smick gives examples: Private equity firms may well leave the country if
the United States
tries to raise its now-favorable tax rate on them, just as there was a “huge
shift out of New York” after
accounting and management reforms were put in place following the Enron
debacle.And it was “disastrous” for France
in 1981 when that country tried to keep capital from leaving.

“…the declining power of central banks… There
are limits to monetary stimulus in contrast to the seemingly endless ability of
the global financial markets to create leverage and risk.”

“…the global financial system… is vulnerable to
a psychological herd effect that could wreak havoc with the industrialized
world economies.”We have seen Smick’s
reference to the Japanese housewives, but the herd effect can be much larger
than even that suggests, with “hundreds of trillions of dollars” subject to
rapid transfer.

Catastrophe can come from within the currency
markets.“…a dollar free fall… could
send the U.S.
economy into complete collapse.”“If the
financial market perception developed that [an] economy was about to weaken,
the traders across the board would dump [the currency], sending it into a free
fall.”There is “a highly leveraged,
globalized ocean of skeptical currency traders.”Greider wrote in 1997: “National governments
watch helplessly as global finance raises their domestic interest rates or
devalues their currencies.”

“China
is a huge unpredictable force with the power to help or sink the world economy…
When the Chinese bubble bursts (and bubbles always do…), China
could instantly become a deflationary threat to the world… China
could have no other choice but to dump [its] stockpiles of commodities and
finished goods onto world markets.”

Further, “because of China’s
daunting challenge, the world is a house of cards in a way no one in the world
yet fully comprehends.”

The Japanese, Chinese and others have purchased
so large a volume of U.S. Treasury bonds that the United
States is extremely vulnerable in case they
decide to pull out.At least a temporary
check on this is that if they bail out precipitously, they will themselves
suffer a major financial loss on their holdings.Further, China
has predicated its social and political stability on production for export to
the United States,
and at least until “its bubble bursts” it is motivated to keep that going.

· Global investors “have placed large amounts of
capital into high-yielding developing-world bond investments.”This has been based on expectations that have
“reflected an incredibly rosy picture that [has] had little in common with
reality.”

The “sovereign wealth funds” established by “China,
Russia, Saudi
Arabia, and other nondemocratic regimes” are
now so large that not even the International Monetary Fund comes close to
matching their amount of capital.In a
global financial crisis, the United States
and Europe may need to seek their help as “our only
hope.”

What Smick
calls “the Great Credit Crisis of 2007-2008” is just one (very important) case
in point.Oddly, it was precipitated by
a relatively small cancer that was metastasized by the financial architecture’s
having been manipulated in a way that resulted in a global loss of
confidence.The toxic subprime mortgages
amounted "to, at worst, $200 billion in exposure in a global market worth
hundreds of trillions.”

Smick says
the global financial system could easily have handled the housing bubble of
$200 billion, were it not for something deeper: the “dubious dual system that
banks and investment companies used to hide their exposure.”The banks set up “structured investment vehicles”
(SIVs) “not under their ownership or control” and whose holdings wouldn’t show
up on the banks’ balance sheets.They
thereby “created their own private market,” and made enormous profits selling
securities to those off-balance-sheet agencies.The costs were passed on to investors around the world: after the toxic
waste was mixed with other loans in “securitized” form, the securities were
“divided… into many smaller portions, and sold… to financial institutions
throughout Europe and Asia.”

When the
real estate bubble burst, “the world’s credit markets seized up… The issue was
not the size of the subprime mess… [but] where the
toxic waste was located… Ultimately, the issue was information, or the lack of
it.”“The panic unfolded precisely
because suddenly nobody could say which financial institutions held the
subprime toxic waste… Securitization [had] resulted in a lack of transparency.”

Smick
captures the spirit of it when he speaks of the “sheer greed” of “bankers and
investment bankers” that was “most responsible for the crisis.”

Beyond that
greed and manipulation, there is the intriguing question of why the eventual
purchasers of the securities were so lacking in “due diligence” in buying
securities they didn’t understand.The
answer lies in the absence of diligent and astute regulation and with the
credit rating agencies upon which the world financial community relied so
implicitly.Smick speaks of “the mother
of all regulatory failures,” since the bank regulators and global credit rating
agencies assured the financial world that the SIV securities were ultra-safe,
having foolishly persuaded themselves that real estate prices will always go
up, never down.“The only measure of
risk and value came from the credit rating agencies, which measured risk merely
on sophisticated mathematical models.”[Smick often describes something, such as securities or the mathematical
models, as “sophisticated” even though by his own account they were at bottom
quite stupid.It is a sign that
technical complexity often trumps wisdom.]

One of the
features of our analogy to bull-riding was that ambulances were standing by to
minister to the casualties.Such ready
assistance isn’t evident for global financial catastrophe.It is chilling when Smick informs us that
“the world today lacks a financial doctrine, or even much in the way of a set
of informal understandings, for establishing order in a financial crisis.”Central banks can try to flood the world with
liquidity to counteract the drying-up of lending and investment, but this is
blocked by “the global market’s lack of confidence.”There is even a term for this blockage: it is
called “a liquidity trap.”In the United
States, “the Fed itself is still trying to
figure out its role in crisis management.”

We have
seen with what fervor Smick praises the benefits of global finance.Now that we know of the horrific dangers
(“world economic collapse”) that he says inhere in it,we see how dubious his notion is that the
world should press on with ever more of it. The worst villains in his scenario are those
who find it intolerable.What really
rankles him is any mention of “protectionism and clumsy financial market
regulatory tinkering.”A “populist
discontent” is “boiling,” with “an emerging era of class warfare.”This, above all, is to be avoided.

A reader
approaches the end of the book with some anticipation that an expert of Smick’s
experience will have specific recommendations to make about how the world can
step back from the precipice.That
expectation is dashed, however, as the pages run out.His prescriptions are broad generalities:

“The United
States should work quickly to bring about an
international effort to correct global imbalances and negotiate a more uniform
global financial structure with greater transparency.”This leaves open the question of how the
imbalances are to be corrected without deviating substantially from the “open
borders” free trade ideology that has led the United
States to flood its market with imports and
several other nations to become export-dependent.It is precisely that ideology that most
informs Smick’s thinking.

“There must
be new mechanisms for increased transparency… Off-the-balance-sheet independent
vehicles must be banned” and the world must “find ways to improve the
performance of the international credit rating agencies.”There must be “surgically precise global
reforms that avoid threatening the larger financial system as a
wealth-generating force.”He doesn’t
advise as to the content of these new mechanisms and surgically precise
reforms.It should be noted, though,
that they do not, in any event,address
the potential catastrophe inherent in “hundreds of trillions of dollars” being
susceptible to herd psychology and to panic whenever there is any tweaking of
confidence.Nor do they speak to the
inability of governments and of central banks to handle such an enormity.

As he
praises the benefits of globalization, Smick gives no attention to the
deindustrialization of the United States
that has come from opening the economy to a gigantic pool of low-cost foreign
labor.Nor does he find it embarrassing
that the United States
has thrown itself so exclusively into the very “global finance” that puts the
peoples of the world in danger from all the threats he describes.And he seems to assume that his praise of
“the global risk-taking entrepreneur” is sufficient without any mention of the
scientific and technical revolution that has come with the computer age.This omission is noteworthy because there is
reason to suppose that the benefits he ascribes to global finance might well be
due at least in large part to that scientific revolution, and would continue
even if financial markets were made much more local and controllable.

Smick does
make an important contribution, however, even though he gives itonly brief
attention.He mentions the growing
polarity of incomes and of wealth in the United
States and elsewhere.He sees that “the middle class has not fully
enjoyed the benefits of the global wealth machine,” and notes that “where the
wage-earning sector… is shrinking, middle-class wages alone may never be enough
to keep families from financially backsliding.”Quite separately from Smick’s analysis, we know that in the advanced
economies work is becoming ever-less compensated, first because of competition
from low-cost foreign labor and ultimately from the rapidly-advancing
automation that introduces non-labor-intensive technology.It is capital, not labor, that will receive
the lion’s share of remuneration in the future.Smick sees this when he says that “mere wage earners, relative to those
with a global stock portfolio, can’t participate in this wealth creation.”This leads him to endorse an idea that is
coming to be taken more and more seriously: the need to make everyone an owner
of capital.He calls for “bringing more
people into the economy as capital owners….”He supports a proposal to “have the federal government give every child
at birth an ‘American Birthright Account’… to be invested in the financial
markets for use later in life.”Although
the proposal is hardly adequate to the magnitude of the advancing displacement
of wage-earners, it is at least a start toward a more comprehensive system of
ownership sharing.

In all, The World is Curved is well worth
reading—not because it is wise, but because of the nightmare scenario it
describes so well.(There is the
possibility, although it seems remote, that the book is not to be taken at face
value.One can imagine a global
financial expert’s wanting to alert the world to the immense dangers, while at
the sametime
toeing the globalist ideological line sufficiently to avoid alienating the
international leaders with whom he has long been closely associated.If that were true here, it would explain the
incongruities—the lack of wisdom—in the book.The reasons for thinking this possibility remote are that in the main
people do genuinely embrace the
ideologies they express, and that years of working in a given professional
milieu generally do create a strong
predisposition in its favor.) Dwight
D. Murphey